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Here’s What Matters to RH Holdings Shareholders -- and What Shouldn't

The retailer you probably still think of as Restoration Hardware had a great quarter, but it’s also setting up to take on significant debt.

When people feel more prosperous, they tend to spend more money on their homes -- decorating, renovating, and generally upgrading. And folks in the upper segments of the wealth curve have been enjoying that sentiment (at least until relatively recently), so it shouldn't be too surprising that RH Holdings(NYSE:RH) has been selling a lot of its premium furniture.

In this segment of the MarketFoolery podcast, host Chris Hill and senior analyst Emily Flippen review the latest numbers, consider the investment thesis for Restoration Hardware, reflect on its niche's position as a lagging indicator of the economy, and more.

A full transcript follows the video.

This video was recorded on Dec. 4, 2018.

Chris Hill: Let's move on to Restoration Hardware. Technically, the company changed their name to RH Holdings, but come on.

Emily Flippen: It's not going to stick.

Hill: It's Restoration Hardware. They had a great third quarter.

Flippen: They did.

Hill: The stock popped about 15% this morning. To go back to Twitter, right before we started recording, I looked at Twitter and saw that Restoration Hardware was halted for trading. Then the news came out that the company is exploring a potential $300 million convertible note offering. Where would you like to start? Do you want to start with the quarter? Or do you want to start with the $300 million note?

Flippen: Let's start with the quarter. The $300 million note doesn't change much for me. Companies do it all the time. I think their quoted reason was "to pursue favorable long-term allocations of capital." For me, it doesn't change very much.

What's really interesting to me, that I really think is a perfect representation of the market right now, is that you have wonderful earnings, a 66% rise in earnings per share, 8% revenue growth. The stock is up a ton. And it's operating in the same segment that we've seen for Toll Brothers in the sense that they're not directly building houses, but this is a luxury product that they're selling to people, presumably, who are living in luxury houses. I don't think a person in an apartment is going to buy a $5,000 sofa. You're looking at home owners, home buyers who are buying premium furniture. So, while the company responded really well in terms of their wonderful earnings report, ultimately, they sell premium furniture. And while home building is one of the leading indicators of a change in economic cycle, inventory to sales ratio is one of the lagging ones. A lot of times, these companies are the butt end of that economic cycle, so they don't start to see poor numbers until people start earning less and they stop spending a ton of money on their furniture.

It was a great quarter. The stock is up a lot. For me, I don't think it says anything about, like I said, the next few years of what earnings are going to be for this company.

Hill: And it's down a little bit from where it was a couple of months ago. But this is still a stock that's up about 60% year to date, which is astonishing to me. Maybe I shouldn't be surprised, but it does surprise me a little bit. Not that it was this down-and-out retailer, it had struggled a little bit in 2016 into 2017. But they've really turned it around.

Flippen: Yeah, they have. Wonderful marketing efforts on their part. What's really interesting to see is that people were very happy to see a comparable store sales growth of about 6%, depending on how you define it, this quarter, which was great, especially when you think about the retail market in general. I've only looked back to 2014. That same number was like 22%, and it didn't see the same large pop that it has now. It's definitely been a stock that has been on a tear, but it's definitely slowing down, as well.

Hill: I'm also a little surprised that it's only about a $3 billion company. The market cap is like $3.3 billion. In part because of the business that they are in and the general footprint that they have, I would have guessed a little bit higher. When I see something like that, particularly a retailer that is doing well, that doesn't have a huge market cap, my mind automatically goes to them being a potential buyout candidate. But they're not really struggling. To go back to the $300 million note that they're offering up, it almost seems like they're saying, "Yeah, we're raising money not because we have to. We're doing it because things are going well, and we're looking to push things a little further."

Flippen: Exactly. Maybe part of that is the perspective that we may have right now as investors. We're kind of accustomed to these very high-value stocks. So, you're right, when we see a company that has a very small market cap that's doing very well, a lot of times, people think, "What's going on there? What's wrong?" When in reality, maybe it's just a small market. The total addressable market for premium hardware, furniture, it's going to be very different than your IKEAs of the world. So, I think part of that is just keeping it in perspective about how many times their average buyer buys one of these, and how large that average buyer base really is.

Hill: To go back to the $5,000 sofa, it's almost akin to the way local car dealerships, the smart ones, think about their addressable market, in that they're looking to sell several cars over a 15-year period to the same person. It's like, I'm going to sell you a car, and hopefully five years from now, I'm going to sell you another one. That sort of thing. If you have a good experience at Restoration Hardware buying a $5,000 sofa, then presumably, you're going to go back, maybe not for more $5,000 sofas, but for more large-ticket items.